Economy facing stagflation risks

16th January 2025

The UK economy is facing increasing risks of stagflation, according to analysis by the ICAEW.

UK business confidence fell by the largest amount in two years to hover just above zero, amid record tax concerns and a slowdown in domestic sales growth. The ICAEW’s Business Confidence Monitor (BCM) for Q4 2024 fell by 14.2 points to put sentiment at just 0.2 on the index, the weakest reading since Q4 2022 and down from 14.4 in the previous quarter.

The dramatic drop in confidence was likely driven by record concerns over the impact of the tax burden and weaker domestic sales growth, ICAEW said. Additionally, companies reported that they expect investment growth to slow in the year ahead, the BCM found, underlining the low sentiment reading.

Drops in confidence were recorded in every sector of the economy, with sentiment moving into negative territory in three areas of the economy. Retail and wholesale businesses were hardest hit at -6.2 on the index, followed by transport and storage at -0.3 and property at -0.2.

By business size, confidence among small and medium-sized enterprises (SMEs) declined into negative territory for the first time since Q4 2022, recording a drop from 12.8 to -4.7. Large companies fared better, with sentiment remaining positive. [3]

The number of businesses reporting the tax burden as a growing challenge hit a record high at 41% in Q4, a significant increase on 29% in Q3 and the first time that tax worries have been the most cited challenge in the BCM’s history. Concerns were partly a reflection of changes to employers’ national insurance in the Budget, which ICAEW members said would have a negative impact on margins. The reduction in the NI threshold also came as a particularly unwelcome surprise, ICAEW said.

Domestic sales growth slowed to 3.2% in the quarter, the lowest since Q3 2021 and down from 3.8% in Q3, likely a result of wider economic conditions and concerns over the impact of October’s Budget. Export growth ticked up to 2.8% quarter-on-quarter, but remained below the historic average. [4]

ICAEW said the government should prioritise measures to boost the wider business environment to ensure Britain was the best place to invest and to start, run and grow a business.

Alan Vallance, ICAEW Chief Executive, said “It’s little surprise that business confidence has fallen considerably. The costs of October’s Budget fell almost solely on business and, as this survey makes clear, our members have expressed concerns about measures that place additional costs on those they support and the wider economy.

“We want Britain to be the best place to invest and to start, run and grow a business. To achieve this, it’s vital that the government delivers on its mission to promote economic growth.

“We hope government will prioritise measures to boost the wider business environment and provide businesses with the clarity and stability they need.”

Suren Thiru, ICAEW Economics Director, said “Our data suggests that the UK economy endured a rather traumatic end to 2024 as slowing domestic activity and the aftershocks from a difficult budget caused business confidence to nosedive.

“While this significant slide in sentiment was broad-based, retailers suffered a particularly difficult time, reflecting their greater exposure to the impact of October’s budget, including the looming increase in national insurance.

“Though slowing selling price and wage costs make a February rate cut more likely by offering hope that the current upswing in inflation may fade, rising expectations for business costs in the year ahead mean policymakers will remain cautious.

“The economy is in a challenging period with stagflation a live risk and there is little in our key forward-looking indicators of sales and investment activity to suggest that a meaningful improvement is likely anytime soon.”

Selling price inflation slowed to its lowest level since Q1 2022 and is expected to slow further in the next 12 months, businesses reported.

Salary growth slowed to 3.1% year-on-year, the lowest rate for more than two years but still double the pre-pandemic average. Notably, wage growth in the next 12 months is expected to slow to its lowest level since Q4 2021.

Businesses reported that their input costs slowed to 3.7%, down from 4.2% in the previous quarter and the lowest since Q4 2021. However, companies lifted their expectations for cost inflation in the year ahead, likely due to the expected impact of the budget and greater global uncertainty.

Against this backdrop, just 11% of businesses cited bank charge – including interest rates – as a challenge in Q4, the lowest since Q1 2022. The Institute said this was probably a reflection of the expectation of continued rate cuts from the Bank of England this year.

Companies reported capital investment growth of 2.6% in Q4, above the historic average of 2.1% and up from 2.4% in Q3. Businesses said that they planned to boost investment by just 1.8% in the next year, with capital investment spending set to be strongest in the energy, water and mining sector and weakest in construction.